What is causing inflation? Economists point fingers at different culprits

What is causing inflation? Economists point fingers at different culprits

Americans continue to experience and hear about the nation’s inflation woes: they’re seeing it fairly clearly in gas and grocery prices, and on their news feeds. 

The inflation rate has exceeded the 40-year high previously set in December, but what remains unclear to many is what is really causing that inflation and when it will come to an end. Obvious to many is that the pandemic has put its thumb on the economic scale, but what exactly is causing the purchasing power of the dollar to falter remains murky.  

That’s not just an issue for the average person, however. While most economists tend to acknowledge the same causes of inflation, many disagree which elements are most driving the price increases that continue to vex American consumers.

Supply chain issues, surging demand, production costs, and swaths of relief funds all have a role to play, they say, but politics tend to cause one to point the finger at the supply chain or the $1.9 trillion American Rescue Plan Act of 2021 as the main culprits. 

A more apolitical view may suggest that all have a role to play in shrinking the distance a dollar can travel. 

“There’s a confluence of factors — it’s both,” said David Wessel, the director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “There’s a lot of things that pushed up demand and a lot that’s kept supply from responding accordingly, as a result we have inflation.”

He said it is inarguable that demand in a pandemic economy surged because of very aggressive fiscal and monetary policies in response to Covid-19. The Obama administration’s stimulus package to respond to the 2008 recession was $787 billion; the pandemic stimulus packages, between the Trump and the Biden administrations, reach around $5 trillion.

That huge sum of money has helped demand come back, but unfortunately the supply chain remains hampered. Hindsight, Wessel said, is 20/20 but he believes the policy was necessary for an even recovery. 

Dean Baker, the co-founder of the left-leaning Center for Economic and Policy Research, agrees. To build an even recovery across the country, that aid was necessary. 

Still, he said, while the stimulus has had a positive effect on the economy, it came as the pandemic drove people to buy products rather than services. Those purchases of couches, cars, refrigerators and other items came as the country’s supply chain remained beleaguered, which drove up demand.  

“I see it as secondary,” he said, “but there’s no doubt it was a factor in driving inflation.”

There remains about $300 billion from the act that is destined to go to states. Experts argue that the Biden administration overheated the economy and ignored signs it was bouncing back. 

“Fiscal policy has been extraordinarily aggressive, and the main example was the American Rescue Plan that was enacted last March, which shot a $1.9 trillion bazooka into a $420 billion output gap,” said Brian Riedl, a senior fellow at the Manhattan Institute and a former chief economist for Sen. Rob Portman, R-Ohio. 

The Biden administration, however, is adamant that the American Rescue Plan Act has not driven inflation. Instead it points to the supply chain struggles and corporations independently driving up prices. 

The White House has also noted the inflationary challenges faced by other countries, arguing this is not an issue of policy but a difficult period driven by the pandemic that many nations are facing.

“Over the past six months, price increases in the United States and Europe have basically run neck and neck,” White House press secretary Jen Psaki said last month when the January inflation numbers were released. “In December, the E.U. saw its highest recorded inflation on record. Germany saw its highest inflation, in December, since reunification. And so, while there are differences country by country, this is a global phenomenon and driven by these global issues.”

What remains inarguable though is this period of inflation is torturing the White House’s political ambitions. 

After losing the battle for Build Back Better to Sen. Joe Manchin, D-W.V., the Biden administration has been aiming to work through pieces of the policy package that consists of around $2 trillion of spending and tax cuts. 

It appears February’s inflation numbers of 7.5 percent have changed the dimensions of that conversation, particularly after Manchin — a pivotal vote in the Senate to pass any Democratic package — said so-called “inflation taxes” were “draining the hard-earned wages of every American.

“It’s beyond time for the Federal Reserve to tackle this issue head on, and Congress and the administration must proceed with caution before adding more fuel to an economy already on fire,” Manchin said after the most recent inflation numbers were released. “As inflation and our $30 trillion in national debt continue to climb, only in Washington, D.C., do people seem to think that spending trillions more of taxpayers’ money will cure our problems, let alone inflation.”

Some argue corporations could have a bigger role in tamping down prices or helping their employees meet them without raising prices further. 

What Baker and other economists fear more than anything, however, is a wage-price spiral, which is when workers demand higher wages to pay for rising prices, and in response, businesses raise consumer prices to evenly match those costs. 

Baker said he’s not demonizing corporations, but it is clear that they have enjoyed outsize profits over the past two years. 

“I think it’s very clear in the data that there was a big shift towards profits in the last two years,” he said. “What’s going on is that companies in response to shortages are raising prices, and that’s disproportionately going to their profits. My takeaway is that there’s room for them to pay higher wages without seeing their profits squeezed.”

The Federal Reserve, meanwhile, has signaled its intent to raise interest rates to address inflation. That would likely help tamp down consumer spending on large purchases and further aid in cooling down the economic situation.

Just stating its intention, Riedl said, will begin to help. It remains to be seen, however, how high the central bank will raise interest rates.

“They need to be careful because we’re still pretty weak coming out of a recession and the economy could pretty easily be pushed back downward,” he said.

“Additionally, raising interest rates doesn’t fix the supply chain. Until we get that resolved, we’re not going to be able to fully solve inflation.”

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